Risk and Return 63One good thing about normal distribution is that it can be described with only two parameters—mean
and standard deviation. The latter captures both upside potential and downside risk. But the investor is
considered with only the former. The downside risk is simply half the total variability. So measuring standard
deviation serves our purpose. The annualized real returns on equities, bonds and bills in different countries
are presented in Exhibit 3.6.
Exhibit 3.6 Annualized real returns on major asset categories worldwide, 1990–2000 (in percent)
Country Equities Bonds Bills
Australia 7.5 1.1 0.4
Belgium 2.5 –0.4 –0.3
Canada 6.4 1.8 1.7
Denmark 4.6 2.5 2.8
France 3.8 –1.0 –3.3
Germany 3.6 –2.2 –0.6
Japan 4.5 –1.6 –2.0
The Netherlands 5.8 1.1 0.7
Spain 3.6 1.2 0.4
Sweden 7.6 2.4 2.0
UK 5.8 1.3 1.0
US 6.7 1.6 0.9
Source:Dimson et al. (2002).
Note: The equities have outperformed bonds and bills in virtually every country. Annual stock
return in the US is 6.7 percent versus 1.6 percent for bonds and 0.9 percent for bills.
That’s not the end of the story. The standard deviation of annual stock returns is usually
more than that for bonds or bills, which suggests that returns are in line with risk.
TYPES OF RISK
The above data suggests that the riskier the asset class, the greater the return. The argument is that investors
are compensated with a risk premium for holding riskier securities. This relation does not hold true for the
Sensex stocks. A scatter plot is displayed in Exhibit 3.7. This scatter plot does not indicate a positive relation
Exhibit 3.7 Risk and return of Sensex 30
Standard deviation–0.060.060.08–0.040.04–0.020.020.00
Mean return